How to Generate Alpha in a Predominently Beta World

CAPM / Alpha Theory 26 Jul 2006

By: Riva Atlas, New York Times
Published: November 30, 2005

Good, quick introduction to portable alpha… 

Except:

“Here’s how it works: An investor with, say, $100 million to invest puts down a fraction – 5 percent or less – to enter into a derivatives contract with a notional value of $100 million linked to the performance of the Standard & Poor’s 500 or some other benchmark index. The investor stands to gain – or lose – the difference between the index’s performance and the cost of the contract.

“That’s the beta component. The remaining $95 million is put into something else that the investor believes will generate a different return, not tied at all to that index. Increasingly, that money is being invested in funds of hedge funds. The $95 million hedge fund investment represents the alpha; it is portable because its return is being combined with that of the beta, or market-tied investment.”

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